November 17, 2014
November, 17, 2014, The Cato Institute
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Economists almost always claim to support the removal of barriers to trade with the argument that it will increase growth, thereby making the trading partners richer. In general this is true, but there can be losers from trade. In the United States, much of the workforce has likely been hurt by policies that were explicitly designed to put manufacturing workers in direct competition with low-paid workers in developing countries. This would be true even if these deals may have led to gains for the economy as a whole.
However it is possible to liberalize trade in ways that lead to economy-wide gains and are structured to disproportionately benefit those at the middle and bottom of the income distribution. The most obvious items on this list are opening up highly paid professional services to international competition and ending patent protection for prescription drugs. The potential savings to consumers would be in the hundreds of billions of dollars annually, dwarfing the impact of almost any other policy.
Importing More Doctors
Highly educated professionals in the United States, especially doctors, get paid far more than their counterparts in other wealthy countries. This is contrast with manufacturing workers in the United States, who generally earn much less than their counterparts in northern Europe.1 This suggests substantial opportunities for economic gains from increased trade in the services provided by these professionals.
As it stands, these politically powerful groups have created an array of licensing and immigration barriers that make it difficult for their foreign counterparts to work in the United States. Good trade policy would seek to knock down the barriers to trade in professional services in the same way that it eliminated barriers to trade in manufactured goods in prior decades.
The goal should be to determine the set of education and training requirements to ensure quality and public safety. (These standards would obviously be higher for doctors and dentists than for lawyers.) These requirements should then be made as transparent as possible so that people anywhere in the world would know what skills they would have to acquire to work in the United States. To minimize costs, people should have the opportunity to test in their home country, by U.S. certified test givers. Any person who met the requirements in their chosen profession would then be able to practice as a doctor, lawyer, etc., in the United States under the same conditions as someone who was born and educated in the United States.
There are more than 800,000 physicians practicing in the United States. If opening the profession to trade allowed for an average savings of $100,000 per physician (which would still leave physicians’ compensation above the average levels in West Europe), this would come to $80 billion a year in savings. Much of this would accrue to the government in the form of lower payments for Medicare, Medicaid, and subsidies in the health care exchanges. The potential savings from lower pay to dentists, lawyers, architects and other professionals that benefit from protectionist measures could easily double this amount, implying annual gains of close to $500 per person.
Bringing the bloated pay for these protected professions down to earth would also have substantial secondary benefits, most importantly in education. One of the problems that schools face in the United States is that teachers’ pay is much lower relative to other measure professions. As a result, most high performing students don’t consider teaching as a career. If the ratio of doctor’s pay to a teacher’s pay was closer to 2 to 1 than 5 to 1, it is likely that many more top students would become teachers.
To ensure this expansion of trade did not hurt developing countries it would be desirable to have a policy of reimbursing them for the cost of education. It would be a relatively simple matter to specify that the taxes paid by foreign trained doctors from developing countries are sent to these countries. This should allow them to educate two or three physicians for every one that leaves to practice in the United States.
Cleaning up the Drug Market
If eliminating barriers to trade in professional services offers large potential gains, the elimination of patent protection for prescription drugs could offer even greater benefits. In 2013 the country spent over $380 billion (2.2 percent of GDP) on pharmaceuticals.2 In almost all cases drugs would be cheap to produce without patent and related protections. It is likely that drugs would have cost only 10-20 percent of this amount if they were sold in a free market in the same way as other products. We would likely also get better drugs. It is necessary to have an alternative mechanism for financing drug development, but it would be difficult to have a worse mechanism than awarding patent monopolies.
If drugs were sold in a free market, there are few drugs that would sell for more than $10-$20 prescription. For the vast majority of people this would make the cost of drugs easily manageable. And the cost to the government of picking up the tab for those who would have difficulty even paying generic prices would be just a fraction of what it is now spending on drugs. Furthermore, moral dilemmas from very high priced drugs, the like $84,000 price tag for the Hepatitis C drug Sovaldi, would quickly disappear if drugs were sold at generic prices. No one would be debating whether we should pay to cure patients of Hepatitis C if it involved paying $900 for the generic version of the drug.
The elimination of patent and related protections is also likely to lead to better health care. Patent monopolies allow drug companies to charge prices that are several thousand percent above the marginal cost of producing drugs. By creating a huge gap between the sale price and marginal cost we are giving companies enormous incentives to misrepresent the safety and effectiveness of their drugs.
And drug companies respond just as economic theory predicts. It is rare that a month goes by where there is not a story about a drug company concealing evidence that its drug might not be as effective or as safe as they claimed. With hundreds of millions or even billions of dollars of profit at stake, it would be shocking if companies did not try to push their drugs even in cases where they may not be the best treatment for specific conditions or certain types of patients.
Drug companies also use the legal and political system to try to maximize the value of their patent protection just as they would with a tariff that protects them from international competition. They use the courts to harass generic competitors, using tactics like spurious claims to secondary patents in order to delay entry into the market. Since there is an inherent asymmetry in this sort of litigation (the brand drug producer is suing to protect a monopoly, the generic producer is trying to get the right to sell a drug at the free market price), the brand producer can often force generics out of the market even with bogus legal claims.
It is not difficult to envision alternative mechanisms to pay for the research currently being incentivized with patent monopolies. Several economists have proposed a patent buyout system, where the government would buy out patents and place them in the public domain. A simpler method, however, would be to have direct public funding. The government already spends more than $30 billion a year to finance biomedical research through the National Institutes of Health (NIH). It would probably be necessary to increase this amount by $50-$60 billion a year in order to replace the funding currently supported through patent monopolies.
This additional funding could probably best be channeled through a mechanism other than NIH, with private companies bidding for major contracts to support research in a variety of areas. By having a relatively limited number of prime contractors, who could then contract out as they please, we would avoid having a situation of the government micromanaging research. The contracts could then be renewed and/or expanded, depending on the company’s track record. The conditions of getting the funding would be both that all patents are placed in the public domain and also that all research findings are made publicly available on the Internet as soon as practical.
This system would have three enormous advantages over the current system. First research findings would be broadly shared among the scientific community as soon as they available. This would eliminate much unnecessary duplicative research. Second, doctors would have access to the full set of test results on various treatment options. This should allow them to make better decisions for the specific conditions faced by their patients. Third, unlike in the current system, researchers would be free to pursue lines of research that may not lead to the development of a patentable product.
This is a sharp contrast with the existing system. If a researcher at a major drug company discovers evidence that a natural substance or long existing drug like aspirin could provide an effective treatment for a specific condition, they have no incentive to do further research in the area. The drug company may opt to make its findings available to the scientific community as a public service, but it certainly would have no obligation to do so, and may choose not out of fear that it will be creating competition for patentable drugs it hopes to develop.
However if research no longer depends on patent support, a contractor could use research findings leading to treatments based on nutrition, exercise regimens, or old drugs as a basis for further funding. There would no longer be the discontinuity that exists today, which could result in many promising leads not being pursued.
The Economic Score
The impact of these two changes on both growth and inequality is likely to be enormous. The combined savings could easily be as much as 2-3 percent of GDP. This dwarfs the potential gains from the trade agreements of the last three decades and most other major policy initiatives. And the gains also come with redistribution from the top to those at the middle and bottom of the income distribution. It is difficult to envision a better way to boost the economy while at the same time reducing inequality.
1. The Bureau of Labor Statistics reports the hourly compensation of manufacturing workers is more than 30 percent higher in Germany than the United States. It is nearly 20 percent higher in France [http://www.bls.gov/news.release/ichcc.t01.html